OGZD.L Regulatory News (OGZD)

MANAGEMENT REPORTOAO GAZPROM 

2010

Contents

The Gazprom Group

Innovative development

Financial and economic trends in 2010

Operating results

Reserves, exploration and production of hydrocarbons

Transportation of gas

Gas underground storage

Gas distribution

Refining

Electric Power

Environment protection

Employees

Analysis of financial results of operations

Results of operations

Liquidity and capital recourses

Capital expenditures

Debt obligations

Shareholder structure and stock market of OAO Gazprom

Management structure of OAO Gazprom

Key Risk Factors

Branches and representative offices of OAO Gazprom

Conversion Table

Glossary of major terms and abbreviations

Addresses and contacts

Notes:

In the present Management Report some of operating and economic parameters have been determined in accordance with International Financial Reporting Standards (IFRS) principles and for the Group entities consolidated in the IFRS consolidated financial statements of OAO Gazprom for the year ended 31 December 2010, therefore they can differ from similar parameters in reports of OAO Gazprom prepared under Russian statutory requirements.

Moreover, some operating parameters of OAO Gazprom and its subsidiaries are determined in accordance with principles underlying management reporting.

Analysis of financial results should be read in conjunction with the audited annual consolidated financial statements of OAO Gazprom for the year ended 31 December 2010, prepared in accordance with IFRS.

The Gazprom Group 

The Gazprom Group (OAO Gazprom and its subsidiaries) is one of the world's largest vertically-integrated oil and gas companies (hereafter Gazprom, the Group). Gazprom has the right for development of one fifth of world's gas reserves and provides for one sixth of world's gas production, being rated the first among oil and gas companies. In Russia Gazprom provides for approximately 80% of gas production and 9% of oil and gas condensate production. The Group carries out field exploration and development projects in fourteen countries of the world.

The Group is the sole owner of the world's largest gas transportation network with length of more than 160 thousands kilometers, which provides natural gas to customers within Russia and to the European markets.Approximately a half of the gas refining in Russia and 14% of oil refining is attributable to Gazprom. 

Gazprom is the dominant gas supplier to Russian market and accounts for approximately 70% of the natural gas demand of other former Soviet Union (FSU) countries, besides the Group supplies approximately a quarter of natural gas consumed in Europe. The Group has branched network of fuel stations of more than 1,500 in Russia, FSU and on Balkans.

The Group also owns electricity generating assets, which provide approximately 17% of the electricity generation in Russia. 

Major operational and financial parameters of the Gazprom Group for 2009 and 2010 are presented in the tables below:

Innovative development

The Gazprom Group views innovative activity and technological upgrade among its priority tasks. Gazprom significantly invests in research and development.

In 2010 innovative research and development costs financed by the Gazprom Group totalled RR 7 billion.

In this area the Group is the leader among Russian energy companies and is in the top ten global energy companies

The Group has innovative projects in all of its core operations. These projects are primarily aimed at enhanced efficiency, stability and safety of production facilities, efficient field development, increased depth of hydrocarbon refinery, and higher quality and competitiveness of produced goods.

Gazprom pays special attention to development and use of Russian high-technology innovations. In particular, it is a Company's priority to increase the Russian component of equipment and technology used in new LNG projects. In addition, Russian modern innovative research and development projects financed by the Group also include:

·; development and pre-production of an environmentally friendly power unit working on fuel elements with a proton-conducting membrane;

·; creation of a new generation of inspection pigs that incorporate a system regulating the speed with which the shell moves in the gas flow as well as a more accurate and reliable system of pipe fault detection.

Mutually beneficial cooperation in the area of science and technology is based on agreements and joint programs and is an integral part of Gazprom's interaction with foreign partners.

This cooperation facilitates an exchange of best operating practices, an exchange of information on prospects and priorities of global technical development of the gas industry, identification of topical science and technology issues the joint solution of which creates a foundation for new international knowledge and technology.

In Europe Gazprom's partners in research and development projects are well known German companies E.ON Ruhrgas AG (E.ON Ruhrgas), BASF SE (BASF), Wintershall Holding GmbH (Wintershall Holding), Verbundnetz Gas AG, Siemens AG, Europipe, as well as N.V. Nederlandse Gasunie, a Dutch company, GDF SUEZ S.A. (GDF SUEZ), a French company, ENI S.p.A. (ENI), an Italian company, and Statoil ASA, a Norwegian company.

In the Asian-Pacific Region the science and technology cooperation is being actively developed with the Korean gas corporation KOGAS, the Chinese National Petroleum Corporation (CNPC), the Agency for Natural Resources and Energy under the Japanese Ministry of Economy, Trade and Industry.

Gazprom stands high in the energy industry. The scope of the Group's operations and accumulated experience enable the Group to set requirements and standards; specify direction of upgrading the industry and related industries that produce equipment and materials for oil and gas companies. Therefore the Gazprom Group is well placed to significantly promote the innovative process in the Russian energy sector as well as in the country economy on the whole.

By developing and implementing innovative technology and processes the Gazprom Group is already at a high level of technological development. Gazprom actively cooperates with leading science and research institutes and centres as well as domestic and foreign companies, animating development of the country's scientific potential. Following the import substitution policy and demanding high quality of products Gazprom is stimulating implementation of advanced technology and solutions by Russian equipment producers.

Gazprom is working on the Program of Innovative Development for the Period to 2020. The Program will be a document of long-term planning and management of innovative operations and will cover all business lines of Gazprom (gas, oil and electric energy). The Program will cover the whole innovative cycle from the development of technical solutions to their practical application. It will connect all elements of Gazprom's organizational and financial procedures dealing with different stages of the innovative process and will regulate interaction of the process participants.

The Program will connect innovative activities and solution of priority tasks faced by Gazprom as well as to ensure that Gazprom becomes an advanced and technology intensive international energy company.

Financial and economic trends in 2010

Recovery of the global economy, and world commodity markets in particular, has significantly affected the economic growth in Russia in 2010. Whilst there have been certain improvements in the Russian economy as compared with 2008-2009 and certain positive movement of macroeconomic indicators, a significant level of uncertainty still remained in the reporting year due to changed market conditions as a result of the 2008 financial and economic crisis. In 2010 Russia's GDP increased by 4%, industrial production increased by 8% while investments into fixed assets increased by 6%; in spite of that inflation went above the initial target limit resulting in 8.8% growth of the consumer price index. In 2010, in order to stimulate financing of real sector the Central Bank of the Russian Federation reduced the refinancing rate from 8.75% to 7.75%. However, many entities in Russia remained short of credit resources.

The above economic conditions have affected, in a varying degree, the operations of the Gazprom Group, including, among other factors, the financial position of our customers. After the decrease of certain operating indicators of the Gazprom Group in 2009, there seems to start their gradual recovery. Nevertheless, the future demand for natural gas and other energy resources remained uncertain in the reporting year, therefore the risk of adverse consequences for the business, financial position and performance of the Gazprom Group also sustained.

In those circumstances, to improve its operating efficiency the Gazprom Group has implemented the 2010 Complex Action Plan on the Group's Financial Strategy. In addition to actions adopted in 2009, the plan included optimization of business processes, management of debt and accounts receivable, development of risk management system and other objectives. Results have been obtained in the following key areas:

·; Debt management: in 2010 the consolidated debt of the Gazprom Group reduced from RR 1,626 billion to RR 1,315 billion; borrowings of Gazprom Group entities were brought under control (existing borrowings of at least a USD 100 million equivalent); the following drafts were developed: Provisional Rules of Raising Debt Financing in OAO Gazprom; Regulation on the procedure of granting loans to Gazprom Group enterprises and organisations.

·; Capital costs optimization in OAO Gazprom: the Group managed to reduced capital investments. Gazprom also designed a procedure for purchasing / selling licensed geological fields that serve / do not serve the company's strategic goals.

·; Procurement system of OAO Gazprom and its principal gas production, transportation, underground storage and processing subsidiaries: testing of the procurement system resulted to certain recommendations that may save up to 5-10% of total procurement costs. In 2010 average prices of inventory purchases were at least 14% lower than in the prior year.

·; Asset management: the merger & acquisition management system is being developed; the dividend policies of certain subsidiaries have been reconsidered to increase the cash flow in favour of OAO Gazprom.

·; Marketing policies: RosUkrEnergo repaid its debt to the Gazprom Group; volumes of supply increased, additional economic benefits were received under a number of contracts with European gas buyers.

It should be highlighted that the Russian Federation continues to display certain characteristics of an emerging market. These characteristics include, but are not limited to, the Russian Ruble's inconvertibility in most countries, restrictive currency controls, and relatively high inflation. The tax, currency and customs legislation within the Russian Federation is subject to varying interpretations and frequent changes. The future economic direction of the Russian Federation is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory, and political developments.

Operating results

Reserves, exploration and production of hydrocarbons

The table below presents assets and volumes of capital expenditures in the Production of Gas and Production of Oil and Gas Condensate segments:

Reserves

According to the audit of Gazprom Group's hydrocarbon reserves under PRMS Standards performed by DeGolyer and McNoton, as of 31 December 2010, proved and probable reserves of the Gazprom Group were as follows: 22.5 tcm of gas, 719.3 million tons of condensate, 1,181.9 million tons of oil, which in the aggregate makes 147.1 bboe. Net present worth at 10 per cent of the Gazprom Group's hydrocarbon reserves is assessed at U.S.$ 269.6 billion, which is U.S.$ 28.2 billion or 11.7% higher than as of 31 December 2009. The valuation covered 93% of natural gas, 86% of gas condensate and 90% crude oil reserves of the Group under ABC1 classification accepted in Russia.

The following table shows proved and probable reserves of Gazprom Group under PRMS Standards:

Note:

(1) The ABC1 classification accepted in Russia is based on analysis of geological parameters of reserves and evaluates the actual hydrocarbon reserves. PRMS Standards take into account not only the probability of hydrocarbon deposition in geological formations but also the economic feasibility of extraction of reserves, determined based on exploration and drilling costs, operating expenses for production and transportation, taxes, hydrocarbon selling prices and other factors. Thus, PRMS information about proved and probable reserves of the Group can not be used for evaluation of reserves that were not subject to PRMS evaluation.

Comparing to the assessment made as at 31 December 2009, the Group's proved and probable reserves increased by 3.7 bboe, this is mainly explained by the inclusion into the estimate under PRMS Standards the Antipayutinskoe and North Tambeiskoe fields located in the Yamal -Nenets Autonomous Area (YaNAO), and by the results of exploration activity on certain fields subject to PRMS evaluation.

As of 31 December 2010 the Group had licenses for ABC1 hydrocarbon reserves development in the following volumes: 33,052.3 bcm of natural gas, 1,284.8 million tons of gas condensate and 1,732.9 million tons of crude oil, for a total of 217.9 bboe.

As of 31 December 2010 the Group's share in the ABC1 reserves of associated companies was 645.4 bcm of natural gas, 57.8 million tons of liquid hydrocarbons and 611.8 million tons of crude oil, for a total of 8.8 bboe.

The following table sets forth changes to the Group's ABC1 reserves of natural gas, gas condensate and crude oil in the licensed areas in Russia in 2010:

Notes:

(1) Under the law of the Russian Federation, the subsoil user does not have any vested right to develop reserves discovered in areas covered by exploration licenses or beyond the licensed areas. Such reserves shall be transferred to the Undistributed Subsoil Fund of the Russian Federation. Subsequently the subsoil user has a preference right to receive a license for their development.

(2) Any changes in gas condensate reserves due to production are recognized as converted into stable gas condensate (C5+). The production volume of unstable gas condensate of Gazprom Group in 2010 was 11.3 million tons.

As compared with 2009 the ABC1 hydrocarbon reserves of Gazprom Group decreased in 2010 by 526.1 bcm of natural gas, 40.3 million tons of gas condensate and 52.1 million tons of oil which is the equivalent of 3,810.2 mboe. That decrease related primarily to the disposal of a controlling interest in OOO SeverEnergiya, which was included within the consolidated financial statements of the Group as an associated undertaking effective 30 November 2010.

As of 31 December 2010 and 2009 ABC1 hydrocarbon reserves of the Group abroad were considered insignificant and accounted for less than 1% of the Group's ABC1 reserves in Russia.

Exploration

Oil and gas exploration in Russia is concentrated mainly in West Siberia which accounts for more than 60% of the total exploration drilling. East Siberia and Far East account for about 25% of the exploration drilling volumes.

Fulfilling the task of expanding its reserves outside of Russia, in 2010 the Group participated in exploration projects in various countries of the world, including Algeria, Bolivia, Venezuela, Vietnam, India, Libya and countries of Central Asia. In 2010 about 60% of total exploration costs were incurred on sea shelves of Vietnam and India under corresponding contracts.

The following table shows summary information on exploration work at licensed areas of Gazprom Group (excluding the work performed by Naftna Industrija Srbije (NIS), a subsidiary to the Group, abroad):

The exploration work in Russia resulted in the increase of reserves by 547.7 bcm of natural gas and 115.5 million tons of crude oil and gas condensate. Recovery of natural gas reserves was 108%, of crude oil and gas condensate - 288%.

In 2010 exploration activities resulted in the discovery of three new fields in Russia, including a major gas condensate Yuzhno-Kirinsky field on the shelf of the Okhotsk Sea within the Kirinsky licensed area, and 26 new deposits. 

The main increase of C1 natural gas reserves on the existing fields relates to the Chayandinsky field in the Republic of Sakha (Yakutia) and Antipayutinsky and Tota-Yakhinsky fields in offshore area of the Gulf of Ob and the Taz Bay.

In 2010 exploration activities performed by the Gazprom Group abroad resulted in the discovery of hydrocarbon reserves within the licensed area El-Assel in the Berkin basin (Algeria) and in the Dzhel platform (plateau Ustyurt in west Uzbekistan). 

Innovations in field exploration

For the purposes of improving the efficiency of exploration works and accuracy of forecasting the reservoir development Gazprom Group is implementing:

·; methods of identifying the areas with complex permafrost conditions in the fields which may result in problems during construction and development works;

·; technologies of forecasting development areas of the oil-and-gas bearing collectors based on fields modelling

Licensing

In 2010 the Gazprom Group received ten licenses, including seven licenses as a result of opening new fields. Costs of license acquisition totaled RR 1.5 billion.

In the reporting year 21 licenses for subsoil use were returned: 7 due to expiry, 14 were terminated early due to inexpediency of any work continuation. Licenses for 18 areas (fields) have been extended.

Transactions with assets that changed controlled reserves and production capacities

Late 2010 OAO Gazprom sold its 51% interest in OOO SeverEnergiya, subsidiaries of which hold licenses for the development and production of hydrocarbons in oil and gas condensate fields in YaNAO. The asset, control over which the Group obtained in September 2009, was bought by OOO Yamal razvitie, a joint venture established on a parity basis by OAO Gazprom neft, a subsidiary to the Group, and OAO Novatek for development of oil and gas condensate fields in the region.

As a result of that transaction the Gazprom Group's effective interest in OOO SeverEnergiya was 25.5% as of 31 December 2010. Hydrocarbon reserves of OOO SeverEnergiya were recorded within the Group's share in hydrocarbon reserves of its associates.

In 2010 the Group acquired a 100% interest in OOO STS-Service, which holds licenses for the development and production of ABC1 reserves of natural gas (1.7 bcm) and oil and gas condensate (4.9 million tons) in Zapadno-Luginetsky and Nizhneluginetsky fields in East Siberia.

Revaluation

In 2010 as a result of the revaluation the amounts of reserves in the territory of Russia decreased by 7.6 bcm for gas and by 0.2 million tons for gas condensate primarily due to changed volumetric parameters in the calculation of reserves in the Kruzhilovsky and Urengoy fields. The oil reserves decreased by 9.1 million tons primarily due to the changed oil recovery factor at oil fields of the Gazprom neft Group.

Production

The following table contains information on the volumes of natural gas and liquid hydrocarbons produced by the Group and associated companies in Russia:

Notes:

(1) Gross of losses incurred in production of natural and associated gas.

(2) Volume of unstable gas condensate extracted from subsoil. In the Russian classification gas condensate reserves are assessed by recalculation to stable gas condensate. In stable condensate terms production of the Group was 8.1 million tons in 2010 as compared with 7.3 million tons in 2009.

Key fields of the Group, production at which was put to a limit due to adverse economic conditions of 2009, were brought back to their project level of gas production in the reporting year. The Zapolyarnoye field accounted for over 50% of the gas production growth.

In 2010 the Gazprom Group's production of gas condensate was 11.3 million tons (or 11.9% higher than in 2009); crude oil production totaled 32.0 million tons (or 1.3 % higher than in 2009). Over 30 % of oil was produced at the Priobsky field in the Khanty-Mansiysk Autonomous Area - Yugra (KhMAO), the Group's most perspective oil fields.

Gazprom's foreign entity, the Serbian concern Naftna Industrija Srbije (NIS), included within the Gazprom neft Group, demonstrated significant production growth. In 2010 oil production of NIS increased to 1.0 million tons or 7.3 million boe.

In 2010 the Group's 49% share of production in Lybia in the framework of C96 and C97 concessions was 0.2 bcm of natural gas and 2.0 million tons of liquid hydrocarbons (or 15.9 million boe in total). The concessions are held by Wintershall AG, an associate undertaking to the Group.

The following table sets forth information on the number of the developing fields and production wells of Gazprom Group:

Main areas of capital investments 

Main investments in the Group's gas production segment in 2010 were allocated to the development of the Bovanenkovskoye field and construction of the railway Obskaya - Bovanenkovo on the Yamal peninsula, development of gas and condensate deposits of Zapolyarnoe field, maintenance of current production levels at Medvezhye, Urengoyskoye and Yamburgskoye fields, development of Kshukskoye and Nizhne-Kvarchinskoye gas condensate fields in the Kamchatsky territory. In 2010 the Gazprom Group put into operation 88 new gas production wells in Russia.

In 2010 capital expenditures for oil production included the Priobskoye and Prirazlomnoye fields as well as the development of the eastern section of the Orenburg oil and gas condensate field. In total in 2010 the Group put into operation 852 new oil production wells in Russia.

In addition the Group financed in its 51% share the implementation of the first phase of the Shtockman field development: the Group allocated RR 3,735.6 million to purchase an additional issue of shares of Shtockman Development AG, an associated undertaking to the Group, which is the operator of the first phase of this project. As a result the Group's 51% interest in Shtockman Development AG remained unchanged.

Sale of oil and gas condensate

In 2010 the Group sold 22.6 million tons of oil and stable gas condensate that closely approximated the volumes sold in the previous year.

Operations of the Group are significantly affected by the prevailing price of crude oil, both in domestic and international oil markets. Crude oil prices have historically been highly volatile, dependent upon the balance between supply and demand, global and regional economic and political developments in oil-producing regions, global economic conditions and are sensitive to the production levels of OPEC as well as the trends of global financial markets.

In 2010 the total growth of global oil prices was about 20%. The price for BRENT crude oil stabilized at around U.S.$91 per barrel by the end of 2010. The following table shows average monthly prices for BRENT and URALS crude oil in 2010 as per Platt's agency:

Notes:

(1) Based on BRENT (Dated) closing quotes.

(2) Based on average closing quotes of URALS Mediterranean and URALS Rotterdam.

Volumes of oil and gas condensate sold on domestic and external markets were as follows:

Note:

(1) The volumes of sold oil and gas condensate by markets do not include intra-group sales. All volumes of gas sold by the Gazprom Group, of own production and purchased from third parties, are included.

Innovations in field development and production

For the purposes of improving the efficiency of fields development including new gas production regions the Group has developed:

technology of low temperature separation and rectification of hydrocarbons of gas condensate fields;

·;

·; multisite observation well design for simultaneous control over terrastatic pressure in several development targets of multilayer oil-gas condensate fields;

·; technology to develop thin, below gas cap oil fringes by using multilateral and multifunctional wells and initializing the vertical oil displacement by the working fluid;

·; model of gas producing field operation as the unified thermal-and-hydraulic system;

·; pipes and fittings for the field underwater and land pipelines with diameter of up to 500 mm and pressure of up to 27.5 megapascal.

Reporting year and subsequent events

At the beginning of 2011 the Gazprom neft Group, within a consortium of state companies KOGAS (Republic of Korea), Petronas (Malaysia) and TPAO(Turkey), joined the project of developing the Badra field in Iraq. The Gazprom neft Group was assigned to the project as the operator with 30% interest. The Badra field development project is scheduled for 20 years and a potential extension for another 5 years. The maximum level of oil production is expected at 170 thousand barrels per day and will be reached starting from 2016.

At the end of 2010 a subsidiary of OAO Gazprom neft and Petronas signed the Agreement on reassignment of a share and the General Provisions of the Joint Operations that address exploration and subsequent development of the four blocks located on the sea shelf of Cuba. In accordance with the above documents a30% interest in the project shall be transferred to the Gazprom neft Group, which shall compensate Petronas a part of the incurred costs and will participate in the financing of current operations pro rata to its share.

In December 2010 the Group sold its 9.4% interest in OAO Novatek to a party unrelated to the Gazprom Group for RR 57,462 million paid in cash.

In March 2011 at a tender held within the bankruptcy procedure OAO Gazprom acquired the property of OAO Rusia Petroleum Company, which was the subsoil user of the Kovykta gas field. The acquired property included a 100% interest in OOO Kovyktaneftegas, which owned property located in the Khandinsky licensed area. Acquisition of this property will allow OAO Gazprom to apply for a re-registration in its own name of the license for the use of the Kovykta gas condensate field with the estimated C1+C2 hydrocarbon reserves of about 2 tcm.

In March 2011 a Memorandum of understanding was signed with Wintershall Holding with regard to a potential asset swap transaction based on exchange of assets in sections IV and V of the Achimov formation of the Urengoy field (the license for the development of the field is held by OOO Gazprom Dobycha Urengoy) for a potential participation of the Gazprom Group in Wintershall Holding's foreign projects.

Development plans for the Production of Gas and Production of Crude Oil and Gas Condensate segments

The strategy of Gazprom Group reserve base development is aimed at maintaining parity between additions to reserves and production of hydrocarbons and ensuring an expended reproduction of reserves in the future.

The required levels of gas production are planned to be maintained in the mid-term perspective by intensively developing acting fields and putting into operation new fields in the Nadym-Put-Tazovsky region and the Yamal peninsula. Gazprom's priorities in hydrocarbon production in Russia are connected with developing Lower Cretaceous gas condensate deposits of the Zapolyarnoye field, bringing the Kharvutinsky platform of the Yamburgsky field to the designed production levels, putting into operation the Zapadno-Pestsoviye field, the Nydinsky platform of the Medvezhiye field, developing the Achimov formation of the Urengoy field and putting into operation Cenomanian-Aptian formation of the Bovanenkovo field in the Yamal peninsula.

In the future new major gas producing centres may be formed on the basis of the Shtockman field, gas resources of Eastern Siberia, Far East and offshore areas of the Gulf of Ob and the Taz Bay. There are plans to continue implementation of gas exploration projects abroad so as to expand the Group's reserve base outside Russia.

The Gazprom neft Group is the base for the development of the Group's oil business. The company intends to increase hydrocarbon production by developing the following priority directions: formation of a new production centre in the north of YaNAO by developing fields of the subsidiaries of OOO SeverEnergiya, the Novoportovsky field and the Messoyakha group of fields, by improving business processes and procedures of managing major projects, by increasing the reserve base, including through new acquisitions. It is planned to expand development of the projects abroad so that they account for approximately 10 % of the total oil production by 2020.

Transportation of gas

The following table contains information on assets and volumes of capital investments in the Transportation segment:

Gas transportation system

In Russia OAO Gazprom owns the largest gas transportation system (GTS) in the world forming the Unified Gas Supply System(UGSS) and can provide an uninterrupted long-distanced gas supply to customers in Russian Federation and abroad.

As of 31 December 2010 the total length of the GTS UGSS was 161.7 thousand km. 215 compressor stations on the pipelines with a total capacity of about 42 thousand MW provided for gas transportation through the system.

The age of the gas trunk pipelines is shown in the table below:

The Group is continually working to improve the reliability and efficiency of the GTS. There have been no major interruptions of gas supplies caused by any failure or fault of the system over the last 10 years. As a result of the regular pipeline repairs, advanced maintenance and diagnostic technology, the incidence of technical faults that involve interruptions or restrictions of gas supply are maintained at a low level. In 2010 seven technical faults of GTS were registered (0.04 faults per 1,000 km) as compared with 14 faults in 2009 (0.09 faults per 1,000 km).

In 2010 the gas transportation system transported 661.2 bcm of natural gas (589.7 bcm in 2009). Gas volumes transported for gas suppliers outside Gazprom Group totalled72.6 bcm, and major gas suppliers were OAO Novatek (33%) and OOO NGK Itera (27%).

In 2010 the average length of transportation was 2,592 km for domestic supplies and 3,262 km for export supplies.

Volumes of natural gas used for own technical needs of the GTS and UGSF were 43.6 bcm of natural gas for 2010 (36.3 bcm of natural gas for 2009). The Group assesses the level of gas losses as low and the level of gas consumed as fuel as satisfactory.

In Russia apart from gas transportation assets of GTS the Group also owns:

·; The gas pipeline Komsomolsk - Khabarovsk with the length of 472.2 km (via control over OAO Daltransgaz);

·; The trunk gas pipeline Sobolevo - Petropavlovsk-Kamchatsky with the length of 394.7 km that was put into operation in September 2010.

The Group's gas transportation assets outside Russia are presented mainly by the part of Yamal -Europe pipeline on the territory of Republic of Belarus and the gas transportation system in the Republic of Armenia. As of 31 December 2010 the Group's gas transportation assets outside Russia included 2.4 thousand km of trunk gas pipelines and five compressor stations with a total capacity of about 416 MW.

Main areas of capital investments

In 2010 the main capital expenditures in the Group's gas transportation segment are allocated to the construction of the trunk pipelines: Bovanenkovo-Ukhta, Sakhalin - Khabarovsk - Vladivostok, Pochinki-Gryazovets and Gryazovets-Vyborg, Dzhubga - Lazarevskoye - Sochi; Sobolevo - Petropavlovsk-Kamchatsky as well as reconstruction and re-equipment of active gas transportation assets. We put into operation 1,338.6 km of gas pipelines and one compressor station with a total capacity of 64 MW.

In addition the Group allocated RR 10,237 million to the North Stream project and made an additional contribution into Nord Stream AG (Nord Stream) in the framework of the additional issue of shares to retain the Group's interest at 51%.  In April 2010 construction of the first line of the North Stream gas pipeline via the bottom of the Baltic Sea commenced.

Innovations in gas transportation

For the purposes of ensuring the reliability and safety of gas transportation, improving the effectiveness of the gas pumping equipment operation the Group has developed and applies:

·; gas-dynamic seals and magnetic bearings of natural gas compressors intended to replace the oil support sealing compressor sections;

·; modern intrapipe pigs having a bypass system to control the shell's speed in gas flow and system to identify the defects of the pipes with the particular accuracy and authenticity.

·; external scanning pigs to identify and assess the defects of pipes and welding joints when performing the capital repairs of trunk gas pipelines by means of re-isolation;

·; pipes and fittings for extra-high pressure - 22.15 megapascal to provide for the construction of pipeline Gryazovets-Vyborg including the rigging of compression station Portovaya.

Reporting year and subsequent events

In February 2010 the Group paid U.S.$625 million to acquire an additional 12.5% interest in OAO Beltransgaz and increased its total interest to 50%.This transaction was the last in a series of transactions performed in accordance with the contract signed between OAO Gazprom and the State Property Committee of the Republic of Belarus in May2007 under which OAO Gazprom acquired a 50% interest in OAO Beltransgaz. Investments in OAO Beltransgaz are recognized as investments in an associated undertaking. 

In March 2010 г. Gazprom and GDF SUEZ signed a Memorandum on the French company joining the North Stream project. A corresponding agreement among five shareholders was signed in June 2010.  As a result of this transaction GDF SUEZ received a 9% interest in Nord Stream after E.ON Ruhrgas and Wintershall Holding sold to it their 4.5% interest each.

In the framework of preparations for the implementation of the South Stream project in March and April 2010 intergovernmental cooperation agreements were signed with Croatia and Austria respectively. Also in April 2010 the basic cooperation agreement was signed between OAO Gazprom and an authorized Austrian company OMV Gas & Power GmbH. Additionally in 2010 joint project companies were established with partner companies from Hungary, Greece and Bulgaria. In February 2011 a joint company was set up with the Austrian partner. In March 2011 OAO Gazprom and its partner from Slovenia signed an agreement to establish another joint project company. Feasibility studies of gas pipeline construction in Serbia and Slovenia, and in Austria and Croatia were completed in 2010 and in the first quarter 2011, respectively.

In June 2010 OAO Gazprom, ENI and EDF signed a trilateral Memorandum that defined specific actions for EDF to join the project of construction of the offshore section of the South Stream project. In accordance with the document EDF will receive at least a 10% interest in South Stream AG (South Stream) due to reduced interest of ENI. Integration of efforts of energy majors from Russia, Italy and France highlighted once again the pan-European nature of the pipeline and became a guarantee of its successful implementation.

In March 2011 in connection with the South Stream project OAO Gazprom and Wintershall Holding, a subsidiary to BASF, signed the Memorandum of understanding, in accordance with which Wintershall Holding is expected to join the project's offshore part. The document provides that Wintershall Holding's interest in South Stream will be fixed at 15% and OAO Gazprom will retain its 50% interest.

Development plans for the Transportation of Gas segment

To ensure reliable gas supply to the domestic market and to fulfil its contracted export obligations the Group is involved in the construction of new transportation capacities.

The priority is given to the construction of the following gas pipelines in the territory of Russia: in the UGSS frame the pipeline SRTO - Torzhok, Bovanenkovo - Ukhta and Ukhta - Torzhok for transportation of gas from the Yamal peninsula fields; the pipeline Gryazovets - Vyborg for transportation of gas to the Nord Stream pipeline and to supply gas to customers of the north-west region of Russia; the pipeline Pochinki - Gryazovets; and the pipeline Sakhalin-Khabarovsk-Vladivostok. In addition perspective projects are being considered such as expansion of the UGSS to ensure supply of gas to the South Stream pipeline and construction of a new gas pipeline Altai to supply Russian gas to China along the western route (if commercial agreement is reached).

Priority foreign projects include construction of the Nord Stream pipeline from Russia to Germany under the Baltic Sea and the South Stream pipeline from Russia to South European countries under the Black Sea.

Gazprom's long-term objectives include the development of gas infrastructure in East Siberia and the Far East.

Gas underground storage

The following table contains information on assets and volumes of capital investments in the Gas Storage segment:

The Group maintains underground storage of gas to help smooth seasonal fluctuations in the demand for gas and to ensure additional supply of gas in case of cold weather or technical failures in the UGSS, also to ensure reliable export supplies and long-term reservation.

Underground gas storages in Russia and abroad

As of 31 December 2010 the Group owns and operates 25 Underground Gas Storage facilities (UGSF) in the territory of Russia with total volume of active gas amounting to 65.4 bcm and potential maximum daily capacity of 620.0 million cm. During the period of peak load, this network of underground storages ensures about 20% of gas supply to Russian consumers and for export and in the days of quick freeze this figure reaches 30%.

The Group also controls one UGSF in the Republic of Armenia, active capacity of which amounts to 0.1 bcm as of 31 December 2010.

For the purpose of increasing reliability of export sales, the Group uses gas underground storage facilities on a lease basis in the territory of Austria (UGSF Haidach), UK (UGSF of the company Vitol), Germany (UGSF Reden and capacity of Vеrbundnetz Gas AG), Latvia (Inchukalnskoye UGSF), France (UGSF capacity of Vitol); it also participates in the construction of new gas underground storage facilities in Europe.

In 2010 47.7 bcm of gas were pumped into UGSFs in Russia and 40.8 bcm were withdrawn, at that utilized maximum daily capacity was 579.5 bcm. Outside Russia 4.3 bcm of gas was pumped into gas UGSFs, the total withdrawal was 2.4 bcm of gas.

Main areas of capital investments

The Group is currently constructing two underground gas storage facilities in Russia - Volgogradsky UGSF and Kaliningradsky UGSF with the active gas volume of 1.1 bcm. In 2010 a significant portion of the capital investments in underground gas storages was allocated to the construction of the Kaliningradsky UGSF, expansion of Nevskiy UGSF and reconstruction of Kaluzhskiy and Sovkhozniy UGSFs.

Gazprom has been involved in the following investment projects abroad: the second stage of UGSF Haidach (Austria), UGSF Katharina (Germany), UGSF Banatsky Dvor (Serbija) UGSF Bergemeer (Nethelands).

Development plans for the Gas Storage segment

The Group is developing the Underground Gas Storage Development Program in Russia for the period 2011-2020 targeting at the daily pumping out capacity of up to 1.0 bcm.

In accordance with decisions of OAO Gazprom Management Committee, action plan is worked out for 2011-2015 aiming at further development of the gas underground storage system, including technical re-equipment and reconstruction of active storage facilities as well as construction of new UGSFs.

Successful implementation of foreign projects will allow Gazprom to significantly increase its gas storage capacity in Europe and to bring it to the level of 5 bcm of active gas by 2015.

Gas distribution

The following table contains information on assets and volumes of capital investments in the Gas Distribution segment:

The Group is the largest exporter of gas in the world. The following table sets out natural gas sales volumes by geographical markets:

Note:

(1) The sales to FSU countries and Europe and other countries include both export from Russia, and sales of gas purchased by the Group outside Russia. According to the law "On Gas Export" dated 18 June, 2006 No.117-FZ, as the owner of the UGSS, OAO Gazprom or its 100% owned subsidiaries have the exclusive right to export gas or liquefied natural gas (LNG) produced in any hydrocarbon field within Russia.

The year 2010 witnessed the global economy's recovery which led to increased gas consumption in the world. Gas consumption in Russia increased by 6.5%; gas consumption in Europe increased by about 8% as per Gazprom's estimate.

Despite the growth of demand the export volumes of Russian gas to Europe and other countries slightly decreased as compared with 2009. Under long-term contracts with OAO Gazprom in 2010 European customers bought 138.6 bcm of natural gas which is 1.4% lower than in the prior year. The sale of Russian gas to European customers under long-term contract continued to be affected by excessive LNG volumes offered on the European market as a result of a simultaneous launch of significant gas liquefaction in the world and re-gasification capacities in European countries.

In 2010 the overall sale of gas to final customers in Europe totalled 4.7 bcm which is 47% higher than in 2009.

In 2010 the Gazprom Group sold 1.82 million tons or 2.47 bcm of LNG (as compared to LNG sales of 1.35 million tons or 1.84 bcm in 2009). In 2010 LNG was delivered to Japan, the Republic of Korea, China, Great Britain and Taiwan.

The price of natural gas in FSU, Europe and other countries

The Group's performance is substantially reliant on natural gas prices on sales to Europe and other countries. Average U.S.$ prices for natural gas increased in 2010 compared to 2009. The prices of our natural gas deliveries to Europe and other countries are basically linked to the global oil products prices. However, due to the six to nine months time lag embedded in the price formulas, our natural gas export prices exercise less volatility compared to the global crude oil prices.

A positive trend of 2010 is the convergence of prices on spot markets and under long-term contracts. If in the beginning of 2010 the difference in prices was over U.S.$100 per mcm, by autumn of the reporting year it reduced almost two times.

Gazprom and gas buyers in Europe and other countries are bound by the system of long-term contracted obligations. Long-term contracts are in fact service contracts that provide the buyer with daily flexibility, differential supply volumes during the year and stipulate the seller's obligation to subsequently replenish the buyer with volumes that were paid by the buyer under "take-or-pay" provision. In addition, long-term contracts provide the buyer with guaranteed supplies of gas for a long period of time. This results in a different scope of risks and different prices for gas under long-term and spot contracts.

In 2010 under conditions of imbalanced gas offer and demand in the European market the Gazprom Group demonstrated a flexible approach to its relations with customers taking into account the unprecedented situation in the European gas market. To avoid any significant deviations from prices under similar competing contracts the Group has been consistently adapting its long-term contracts including by way of introducing a limited spot component into them. However, fundamental provisions of the contracts that determine the balance of interests between the supplier and the buyer remained unchanged.

The following table shows the average prices of natural gas sales to FSU, Europe and other countries in 2010 and 2009:

Note:

(1) Calculated based on annual average currency exchange rate between RR and U.S.$

Increase in the average price of natural gas sales to FSU as compared to the prior period mainly related to the fact that Gazprom started providing FSU customers with contractual prices the earning capacity of which is similar to the European prices.

Domestic natural gas prices

In 2010 the average price of gas sold by the Group in the domestic market remained lower than export prices (without regard to export duties and transportation costs), which is related to the regulation of gas wholesale prices in Russia by the Russian Government.

From 1 January 2010 the regulated wholesale gas prices for industrial consumers increased by 15%. For residential consumers gas prices increase by 5% from 1 January 2010 and by 15% by 1 April 2010. Average wholesale gas prices for all consumers increased by 26.3% as compared to 2009.

The following table shows the average domestic natural gas prices:

Note:

(1) Calculated based on annual average currency exchange rate between RR and U.S.$

Main areas of capital investments

A significant portion of capital expenditures in Gas Distribution segment includes the Group's investments in gasification of the regions of the Russian Federation. In 2010 the gasification program was implemented in 67 territorial subjects of the Russian Federation. The construction of 156 gasification facilities with total length of 2.1 thousand km was completed; financing totalled RR 25.6 billion.

Reporting year and subsequent events

In April 2010 OAO Gazprom and NAK Naftogas of Ukraine signed supplements to the gas supply contract dated 19 January 2009. In 2010 annual contracted gas volume increased to 36.47 bcm. NAK Naftogas of Ukraine will pay for gas with a discount equal to the amount by which the export duty on gas supplies to Ukraine is decreased and which is determined by the Government of Russian Federation.

In 2010 the LNG plant constructed under the Sakhalin-2 project and operated by Sakhalin Energy Investment Company Ltd. ("Sakhalin Energy") was up and running to its full capacity of 9.6 million tons per year.

In September 2010 OAO Gazprom subsidiaries and CNPC signed the Expanded Principal Terms of Gas Supply to underlie all sale and purchase contracts. After the contract is signed (which is expected in 2011) the parties will be able to launch the construction of the Russian and Chinese parts of the pipeline. Gas supplies along the western corridor are expected to start at the end of 2015. As to the eastern corridor, supplies of gas can be organized after 2017 there. Projects related to gas supplied along western and eastern corridors are aimed at meeting the demand for gas in different regional markets of China and are complementary in nature.

Development plans for Gas Distribution segment

The Group's strategy in the Russian domestic market consists of ensuring a continuous gas supply to our domestic customers while improving the profitability of sales. One of the main landmarks of domestic gas market development is moving from the regulation of wholesale gas prices to the regulation of gas trunk pipelines transportation tariffs.

On 31 December 2010 the Russian Federation Government adopted Resolution No.1205 that provides for further improvement of the state regulation of gas prices in the direction of their liberalization. The Resolution envisages a transition period from 2011 to 2014. In this period conditions will be created to apply market pricing methods that are based on the principle of equal profitability of export and domestic supplies of gas. To ensure a gradual raising of domestic prices to their equal profitability with export prices the Russian Federal Tariff Service (FTS) is put in charge of setting up decreasing coefficients in the transition period. These coefficients are components of the gas price formula; they take into account specifics of domestic market pricing. For 2013-2014 the Russian Government has set the variation limits that are calculated at the price formula based on the average level. Such variations are within the range from -3 to +3 percentage points. The above pricing principles will be applied to gas supplied to all customers (except for residential customers).

The Group's key objectives in the European market are to maintain the market-leading position, provide for reliable gas supply, and increase the efficiency of our marketing activities. The Group plans to achieve these objectives by developing relationships with traditional customers on a long-term contractual basis and using new forms of trade based on short-term and medium-term sales, as well as gas exchange and one-time transactions. The Group intends to increase its ownership in companies engaged in the sale of gas and electricity to end-users.

The key objectives of Gazprom's marketing strategy in the FSU countries are to ensure that Russian gas will continue to maintain its leading position in the energy sector of the region and to expand access to the end-consumers.

To ensure the flexibility in determining the development stages for fields in the new gas producing regions in Russia, the Group cooperate with Central Asian and other countries in developing gas reserves, upgrading and modernizing gas transportation systems.

As part of the strategy to diversify the sales geography the Group considers the countries of Asia-Pacific Region as key new markets, access to these markets is expected to be obtained through stage-by-stage development of production, trade and marine transportation of LNG.

Refining

Assets and volumes of capital investments in Refining segment are presented in the table below:

Processing of hydrocarbons and production of refined products

In 2010 natural gas and gas condensate was processed by gas processing and gas production subsidiaries of OAO Gazprom (OOO Gazprom Pererabotka, OOO Gazprom Dobycha Astrakhan, OOO Gazprom Dobycha Orenburg, Vostokgazprom Group), crude oil was refined at capacities of the Gazprom neft Group - at Omsk Refinery, Moscow Refinery and OAO NGK Slavneft entities and NIS oil refineries.

The following table sets forth the volumes of the Group's hydrocarbon processing for the periods indicated:

Notes: 

(1) The data in tables do not include raw materials supplied by customers.

(2) NIS data is included in the Group's figures from February 2009. Sibir Energy's refinery volumes at OAO Moscow Refinery were consolidated effective the end of the second quarter of 2009, when the Group obtained control over Sibir Energy.

As of 31 December 2010 the total processing and refining capacity of the Group was 52.5 bcm of natural gas and 75.4 million tons of unstable gas condensate and crude oil.

The following table sets out production volumes of major refined products for the periods indicated.

Notes: 

(1) The data in tables do not include raw materials supplied by customers.

(2) NIS data is included in the Group's figures from February 2009. Sibir Energy's refinery volumes at OAO Moscow Refinery were consolidated effective the end of the second quarter of 2009, when the Group obtained control over Sibir Energy.

The increase in gas refinery is explained by increased production of gas, gas condensate and oil in 2010 due to recovery of the global and domestic markets from the crisis; the increase of oil refinery is explained by consolidation of Sibir Energy, which is a shareholder of OAO Moscow Refinery.

Sales of refined products

The following table sets out the sales of refined and petrochemical products by Gazprom Group:

Notes: 

(1) Presenting the volumes of refined products and petrochemicals sold to the consumers of the corresponding sales markets less intercompany sales. The data include sale volumes of refined products produced by the Gazprom Group and purchased from third parties.

(2) The volumes do not include helium and tires.

The increase in refinery product sales in 2010 is explained by reaching the planned levels of gas production and refinery as compared with the reduced refinery levels in 2009, and by increased oil refinery volumes of the Gazprom neft Group after the consolidation of Sibir Energy's share in the refinery volumes of OAO Moscow refinery, the development of premium sale segments and increased demand on the whole market of refinery products.

In 2010 the Group's sales of helium reached 4.9 million cm, which corresponds to the 2009 level.

The Group continues to strengthen its positions in the oil product retail sales in Russia and abroad. As of the end of 2010 the number of operating fuel stations increased to 1,596 stations, including 649 stations located abroad. As of the end of 2010 the single retail brand of "Gazprom neft" covered 950 fuel stations (including 455 partially rebranded stations).

In 2010 the volume of oil products of the Gazprom Group that are sold via the network of fuel stations increased by 41.4% and reached 4.85 million tons as compared with 3.43 million tons in 2009.

Main areas of capital investments

In 2010 the capital investments were mainly made in the development of Novy Urengoy gas chemical plant, construction of the condensate pipeline Zapolyarnoye - Urengoy, construction of new units and modernization of the existing ones at the Omsk refinery and OAO Moscow Refinery, upgrade of NIS refinery capacities at the refinery plant in Panchevo, acquisition of a network of fuel stations and land plots for fuel stations construction in Kazakhstan as well as reconstruction and re-branding of the fuel stations network. 

In 2010 construction of a diesel hydro treating unit and a FCC gasoline hydro treating unit was launched at the Omsky refinery. These units will produce diesel fuel and petrol of class 4 and 5.The largest in Europe light naphtha isomerisation unit Izomalk-2 was put into operation. A unit producing emulsified polymer bitumen and bitumen emulsion was also put into operation.

In 2010 the condensate pipeline Zapolyarnoye - Urengoy, 210.9 km long, was put into operation, it will allow to increase utilization of the current capacities of Urengoysky ZPKT and Surgutsky ZSK.

Construction of light hydro cracking and hydro treating units was launched in 2010 within the process of modernizing NIS refinery capacities at the refinery in Pancevo, Serbia. The project will help to increase refinery volumes up to maximum plant's capacity of 4.8 million tons a year.

Innovations in processing of hydrocarbons and production of oil and gas products

For gas processing purposes the Group is implementing the projects on:

·; developing the testing and production facility to produce the synthetic liquid fuels with the capacity of 100 thousand tons per year;

·; low-tonnage installation to produce super-gasoline to be used at depleted and low pressure wells.

For the purposes of rational utilization of the helium-rich fields the technology of complex raw processing to produce LNG and separate helium and technology and technical decisions related to transportation and storage of helium are being developed.

In order to increase the depth of liquid hydrocarbon raw processing and improving the quality of the produced petrol in accordance with Euro-4 and Euro-5, the secondary processing of the stable gas condensate and oil are being implemented.

In addition, other projects are being carried out:

·; developing the technology of HSFO processing at Astrakhan gas processing plant by using the electron-stimulated cracking;

·; implementation of sulphur bituminous for the purposes of construction and repairing the highways.

Development plans for the Refining segment

The main objective of the Group's development in gas processing and gas chemistry is to increase the rate of extraction of valuable components of natural and associated oil gas and their effective use for further refining to marketable products with high added value; build up new gas processing and gas chemistry facilities, including in Eastern Siberia and Far East.

To ensure transportation of increased volumes of gas and gas condensate from new sites put into operation in Western Siberia it is planned to expand and reconstruct the Urengoy gas condensate treatment plant so as to increase its capacity by 12 million tons of de-euthanized condensate by 2014; to create treatment and transportation facilities for gas and oil from the Achimov formation and to finalize construction of the condensate pipeline Urengoy - Surgut; it is also planned to expand and reconstruct the Surgut Stable Condensate Plant.

The oil business development strategy provides for increased volumes of oil refinery due to increased scope of own oil refinery capacities in Russia and abroad.

Strategic goals set by Gazprom in refinery include production of goods that comply with the technical regulations, i.e. classes 4 and 5, increased depth of refinery to 90%-95% and yield of light fractions up to 79%. Moreover, the technological level of refineries should correspond to global standards, including in ecology and safety.

Strategic goals in the area of marketing include: increased sales of oil products through marginal sale channels in Russia and abroad, building up a strong retail brand, a 20% increase in the average flow of a filling station and a two times increase of the accompanying goods and services' share in the revenue. The growth of retail sales will be based on the expansion of filling stations network through acquiring existing networks and entering new regions of Russia and FSU countries.

Electric Power

The following table shows assets and capital investments related Electric and heat energy generation and sales segment:

The Gazprom Group is the largest owner of power generating assets in the Russian Federation. The total installed capacity of the Group's main generating companies in Russia (OAO Mosenergo, OAO TGC-1, OAO WGC-2 and OAO WGC-6) is about 36 GW, or 17% of the total installed capacity of the Russian energy system.

Information on the Group's key generating assets in Russia and abroad is presented in the table below:

Note: 

(1) Totals may not add up due to rounding.

In 2010 the Group's power generation increased by 26.4% to175.1 billion kWh as compared with 138.5 billion kWh in 2009.

All power generated by the Group is sold at the wholesale market of electricity and power capacity.

In 2010 heat production totalled 106.9 million Gcal which is 45.6% higher than in 2009.

The increase in sales of electricity and heat in the Gazprom Group mainly results from the consolidation of OAO TGC-1 in 2009.

In addition, improved performance indicators of the Group's generating companies in 2010 are also explained by increased demand for electric power in the regions where these companies operate mainly due to the growth of industrial production in Russia.

Main areas of capital investments

In 2010 the Group primarily invested in modernisation of Kirishskaya TPP based on steam-gas technology and construction of a carbon block with circulating fluidized bed (CFB) at Novocherkassky TPP (OAO WGC-6); construction of the steam-gas power generating units at Pervomaysky TPP-14 and Yuzhny TPP-22 (OAO TGC-1) as well as construction of Adlersky power-generating station.

Under the Gazprom Group's investment program new generating capacities of 676 MW, or 21% of the total new capacities in Russia for the period, were put into operation in 2010. In addition OAO Mezhregionenergostroy, a related party to the Group, put into operation the second power generating unit at Kaliningradsky TPP-2 with the capacity of 450 MW.

Outside Russia the Group is involved in the construction and modernization of the fifth power generating unit of Razdansky TPP (Armenia). After the unit is put into operation Gazprom will have a significant share in the power generating market of Armenia and will be able to supply electric power to its neighbouring countries. The fifth power generating unit of Razdansky TPP is expected to be put into operation in the second half of 2011.

Innovations in electric power

Gazprom Group is implementing a number of large-scale projects having no parallel in the Russian power energy:

·; modernization of a steam-power block of Ryazansky TPP of OAO WGC-6 by adding gas turbine capacity of 110 MW of OAO Saturn-Rybinsky motors (increase in thermal efficiency up to 45%);

·; the construction of a carbon block with CFB-330 at Novocherkassaya TPP which will enable to use the several different coal types including those of bottom quality for boiler equipment operation is under way;

·; at OAO Gaprom production facilities the modern reducing valve generator units using the technological drop of natural gas pressure are being implemented. Reducing valve generator units ensure the generation of the additional electricity with CNG energy efficiency at not less than 80%.

Development plans for electric and heat energy generation and sales segment

The development strategy of Gazprom Group's energy sector provides for a qualitative improvement of generating companies' operating efficiency and their capitalization growth. Accomplishment of the investment program is also a priority for development of the energy companies: the Group's strategy up to 2020 provides for the growth of generating capacities to 44.8 GW.

Implementation of the strategy will allow Gazprom to retain and strengthen its leading position in the electric power market of Russia as well as to bring efficiency factors to the level of major global power generating companies.

Environment protection

In its operations, Gazprom is guided by the principle of strict compliance with rules of international and Russian environmental legislation.

In 2010 statutory environmental inspections identified no significant violations of the Russian environmental legislation by the Group's companies. Penalties related to violation by Gazprom of environmental legislation in 2010 amounted to RR 1.8 million (by 10% less than in 2009).

The main indicators of the Gazprom Group impact on environment are presented below:

The Group's power assets account for the main contribution in the formation and movement of waste generation and discharge of water waste in surface water bodies. The Group's power assets account for 98% of taken and discharge water. At the same time 99.7% of waste water volume that go to surface waters are clean as per regulatory requirements or have been cleaned at treatment facilities.

Gazprom Group's environmental costs are disclosed below:

In 2010, CO2 emissions of the main Gazprom's subsidiaries in production, transportation and underground gas storage operations increased by 6 million tons of CO2 - equivalent as compared with the prior year and amounted to 137 million tons of CO2 - equivalent. This dynamics is explained by the increase in natural gas consumption for compressing resulting from increase in gas production and transportation

In line with the Energy Strategy of Russia up to 2030 and with the Climate and Ecology Doctrines of the Russian Federation, OAO Gazprom strictly adheres to the corporate policy of Earth climate protection. Participation in international organizations, working out environmental standards in accordance with the international agreements, conducting research and special projects aiming to decrease in emissions of greenhouse gases, efficient usage of associated gases - those are the main components of Gazprom's policy for climate protection.

Employees

In its operations, the Group complies with all requirements of the conventions of International Labour Organization ratified by the Russian Federation. Guided thereby, the Group complies with international standards related to freedom of associations, salary, duration of the working day and labour conditions, employees' compensation for their work, social security, provision of paid vacation, labour safety, etc.

As of 31 December, 2010 the number of employees in the Gazprom Group's subsidiaries was 400.6 thousand people, including 21.3 thousand employees of Gazprom Group's entities registered abroad.

The structure of Gazprom Group's employees as of 31 December, 2010 is provided in the following table.

The table below shows the level of education of Gazprom Group staff as of 31 December, 2010.

Professional training of workers is carried out in training divisions of subsidiaries, training of graduates - in corporate and governmental educational institutions. In total 188.9 thousand employees were covered by professional training in 2010.

In 2010, the Group's costs on employee training (including business trip costs) totaled RR 2.16 billion which represents a 35% increase (or an increase by RR 0.56 billion) as compared with 2009.

In 2010, social and labour relations between employees and employers in the Group's entities were regulated by labour legislation, Industry Agreement for Entities of Oil and Gas Sectors and Construction of Oil and Gas Facilities of the Russian Federation for 2008-2010, Industry Tariff Agreement in the Russian Utilities Sector for 2009-2011, General Collective Agreement of OAO Gazprom, its subsidiaries and entities for 2010-2012 and by subsidiaries' and entities' collective agreements.

The General Collective Agreement of OAO Gazprom, its subsidiaries and entities for 2010-2012 affects interests of more than 300 thousand employees.

The established social partnership system allows regulating social and labour relations in accordance with the changing economic and social environment, on-going balancing of personnel's and employer's interests without decrease in the achieved level of material protection of employees and their families, maintaining social stability and attractiveness of Gazprom Group entities in the labour market.

Analysis of financial results of operations

Results of operations

(RR million)

Sales

The following table sets out our volumes and realized prices

Notes:

(1) VAT is not charged on sales to Europe and other countries.

(2) Calculated on the basis of annual average currency exchange rate between RR and U.S.$.

Total sales (net of excise tax, VAT and custom duties) increased by RR 606,053 million, or 20%, to RR 3,597,054 million in the year ended 31 December 2010 compared to the year ended 31 December 2009.

Net sales of gas accounted for 61% and 64% of total net sales in the year ended 31 December 2010 and 2009, respectively.

Net sales of gas increased from RR 1,918,503 million in the year ended 31 December 2009 to RR 2,186,205 million in the year ended 31 December 2010, or by 14%.

Net sales of gas to Europe and other countries decreased by RR 6,228 million or 1%, to RR 1,099,225 million in the year ended 31 December 2010 as compared to the year ended 31 December 2009. This mainly results from the decrease of gross average realized prices in RR terms (including excise tax and custom duties) by 3%.

Net sales of gas to FSU countries increased by RR 140,208 million, or 45%, to RR 450,137 million in the year ended 31 December 2010 as compared to the year ended 31 December 2009. This increase was mainly due to increase in volumes of gas sold to FSU countries by 24% in the year ended 31 December 2010 compared to the year ended 31 December 2009, and increase in gross average RR price (including custom duties, net of VAT) by 10% in the year ended 31 December 2010 compared to the year ended 31 December 2009.

Net sales of gas in the Russian Federation increased in the year ended 31 December 2010 compared to the year ended 31 December 2009, by RR 133,722 million, or 27%, to RR 636,843 million. This increase was mainly due to 25% increase in the gross average gas sale price regulated by the Federal Tariffs Service (FTS), and 1% increase in the volumes of gas sold.

Net sales of refined products (net of excise tax, VAT and custom duties) increased by RR 168,557 million, or 31%, to RR 709,062 million in the year ended 31 December 2010 in comparison with RR 540 505 million in the year ended 31 December 2009. The increase mainly resulted from increase of world prices for refined products and increase in volumes sold by the Group as well as from the acquisitions of subsidiaries by the Gazprom neft Group in 2009. In the years ended 31 December 2010 and 2009 the Gazprom neft Group's sales comprised 84% and 85% of the total amount of our net sales of refined products, respectively.

Net sales of electric and heat energy (net of VAT) increased by RR 95,829 million, or 50%, to RR 288,655 million in the year ended 31 December 2010 as compared to the year ended 31 December 2009. RR 49,687 million of the total increase related to consolidation of TGC-1 effective 31 December 2009 when control over that entity was established. Another reason for the total increase in the Group's electric and heat energy net sales was an increase in electric and heat energy sales of Mosenergo, WGC-2 and WGC-6 by RR 45,487 million, or 24%.

Net sales of crude oil and gas condensate (net of excise tax, VAT and custom duties) increased by RR 19,671 million, or 11%, to RR 196,074 million in the year ended 31 December 2010 as compared to RR 176,403 million in the year ended 31 December 2009. The increase was mainly caused by increase in price for oil and gas condensate as well as by increase in volumes of gas condensate sold in the year ended 31 December 2010 as compared to the year ended 31 December 2009. Sales of crude oil included in net sales of crude oil and gas condensate (net of excise tax, VAT and custom duties), amounted to RR 169,193 million and RR 157,874 million in the years ended 31 December 2010 and 2009, respectively.

Gas transportation net sales (net of VAT) increased by RR 27,068 million, or 41%, to RR 92,631 million in the year ended 31 December 2010 from RR 65,563 million in the year ended 31 December 2009. The increase was mainly caused by increase in gas volumes transported for independent gas suppliers.

Other revenues increased by RR 27,226 million, or 28%, to RR 124,427 million in the year ended 31 December 2010 compared to RR 97,201 million in the year ended 31 December 2009.

Net gain from trading activity increased by RR 2,085 million, or 50%, to RR 6,256 million in the year ended 31 December 2010 in comparison with the year ended 31 December 2009. This growth is due to increase of trading operations by Gazprom Marketing and Trading Ltd., a subsidiary to the Group, under the terms of gas sales contracts. 

Operating expenses

Operating expenses increased by 17% in the year ended 31 December 2010 to RR 2,440,777 million from RR 2,092,832 million in the year ended 31 December 2009. Operating expenses as a percentage of sales decreased from 70% in the year ended 31 December 2009 to 68% in the year ended 31 December 2010. The table below presents a breakdown of operating expenses in each year:

Purchased gas and oil

Cost of purchased gas and oil increased by 1% to RR 616,407 million in the year ended 31 December 2010 from RR 607,310 million in the year ended 31 December 2009. The cost of purchased gas decreased by RR 41,590 million or 9% and amounted to RR 401,725 million for the year ended 31 December 2010 which is mainly explained by decrease in prices and volume of gas purchased outside the Russian Federation. The cost of purchased oil increased by RR 50,687 million, or 31%, and amounted to RR 214,682 million in the year ended 31 December 2010 in comparison with RR 163,995 million in the year ended 31 December 2009 due to increase of world oil prices.

Staff costs

Staff costs increased by 34% to RR 342,846 million in the year ended 31 December 2010 from RR 255 977 million in the year ended 31 December 2009. Staff costs included costs for pension expense in the amount of RR 64 990 million and RR 20 486 million for 2010 and 2009, respectively. The increase in staff costs (without pension expense) resulted mainly from increase in the average salary. The increase was also due to consolidation of TGC-1 effective 31 December 2009 when control over that entity was established; and due to acquisitions of new assets by the Gazprom neft Group in 2009. Increase in pension expense related primarily to unfunded post-retirement benefits such as funeral payment, health improvement, medical aid and other types of financial support to pensioners.

Taxes other than on income

Taxes other than on income consist of:

The natural resources production tax increased by 18% to RR 170,455 million in the year ended 31 December 2010 from RR 144,908 million in the year ended 31 December 2009. The increase mainly relates to the production of crude oil and was caused by the increase of world oil prices that in turn resulted in the increase of tax rate.

Transit of gas, oil and refined products

Transit of gas, oil and refined products increased by 18% to RR 260,776 million in the year ended 31 December 2010 from RR 220,961 million in the year ended 31 December 2009. This growth mainly relates to increased costs of gas transportation through Ukraine.

Depreciation

Depreciation increased by 10% or RR 22,418 million to RR 243,615 million in the year ended 31 December 2010 from RR 221,197 million in the year ended 31 December 2009.The increase primary relates to the growth in the fixed asset base.

Repairs and maintenance

Cost of repairs and maintenance increased by 15% to RR 159,894 million in year ended 31 December 2010 from RR 138,779 million in the year ended 31 December 2009. This increase was mainly caused by increase in volume of repair services rendered by third parties to the Group in the year ended 31 December 2010.

Materials

Cost of materials decreased by 1% to RR 83,043 million in the year ended 31 December 2010 from RR 83,576 million in the year ended 31 December 2009. This decrease was partially compensated by the increase in cost of fuel in operating segment "Electric and heat energy generation and sales" as well as by increase in costs resulting from the changes in the Group's procurement logistics as related to the capital repair activities.

Cost of goods for resale, including refined products

Cost of goods for resale, including refined products increased by 34% to RR 70,072 million in the year ended 31 December 2010 from RR 52,203 million in the year ended 31 December 2009. The increase is mainly due to the increase in prices for oil and oil products.

Electricity and heating expenses

Electricity and heating expenses increased by 39% to RR 60,386 million in the year ended 31 December 2010 from RR 43,375 million in the year ended 31 December 2009. The increase mainly resulted from increase in electricity consumption, growth of electricity tariffs and consolidation of OAO TGC-1 effective 31 December 2009.

Exchange rate differences on operating items

Exchange rate differences on operating items in the year ended 31 December 2010 amounted to a net loss of RR 12,876 million compared to net gain exchange rate differences on operating items in the amount of RR 44,223 million in the year ended 31 December 2009. The change was primarily driven by depreciation of RUR against USD by 1% and by appreciation of RUR against EUR by 7% in the year ended 31 December 2010 comparing to depreciation of RUR against USD and EUR by 3% and 5%, respectively, in the year ended 31 December 2009.

Other operating expenses

Other operating expenses increased by 15% to RR 179,815 million in the year ended 31 December 2010 from RR 155,843 million in the year ended 31 December 2009. Other expenses include heat energy transmission expenses, bank charges, security services, legal and consulting services, advertisement services, gas storage services, charity and financial aid and others.

Impairment provision and other provisions

In the years ended 31 December 2010 and 2009 the Group has assessed whether there were any indicators that non-current assets of the Group might be impaired. No such indicators were identified.

Included in the impairment and other provisions are provisions for short-term and long-term accounts receivable in the amount of RR 48,448 million and RR 33,586 million for the years ended 31 December 2010 and 2009 respectively.

Operating profit

As a result of the factors discussed above, our operating profit increased by RR 256,910 million, or 30%, to RR 1,113,822 million in the year ended 31 December 2010 from RR 856,912 million in the year ended 31 December 2009. Our operating profit margin increased from 29% in the year ended 31 December 2009 to 31% in the year ended 31 December 2010.

Purchase of non-controlling interest in OAO Gazprom neft

In April 2009 the Group purchased an additional 20% interest in OAO Gazprom neft for USD 4.1 billion (approximately RR 138,527 million) from ENI S.p.A. As a result of this transaction, the Group increased its interest in OAO Gazprom neft to 95.68%. The difference between the carrying value of the acquired non-controlling interest (approximately RR 152,392 million) and purchase consideration was recognized as a gain in the amount of RR 13,865 million in the consolidated statement of comprehensive income.

Disposal of interest in OAO Novatek

In December 2010 the Group sold a portion of the associated undertaking (total carrying value of RR 84,978 million as of the date sold) representing a 9.4% interest in OAO Novatek to a party unrelated to the Group for RR 57,462 million paid in cash. As a result of this transaction the Group has ceased to exercise significant influence over the business activities of OAO Novatek. Therefore the remaining 9.99% interest was classified as long-term available-for-sale financial asset and was recognized at fair value in the amount of RR 104,484 million at the date of disposal.

In the consolidated statement of comprehensive income for the year ended 31 December 2010 the Group recognized a gain of RR 77,375 million representing the difference between the sum of fair value of the remaining 9.99% interest at the date of transaction, cash proceeds from disposal of 9.4% interest and accumulated net gain previously recognized in other comprehensive income in relation to this associated undertaking, and the carrying amount of total 19.39% interest as at transaction date.

Gain from transaction for asset swap with E.ON Ruhrgas AG

On 30 October 2009 the Group closed the swap agreement with E.ON Ruhrgas AG. As a result thereof, the Group swapped its 25% share in OAO Severneftegazprom less three ordinary shares, three preference shares without voting right of OAO Severneftegazprom and a preference share in ZAO Gazprom YRGM Development for a 49% interest in ZAO Gerosgaz and a cash compensation of Euro 67 million. OAO Severneftegazprom holds the license for the development of Yuzhno-Russkoe oil and gas field in Siberia. ZAO Gerosgaz is the company holding the investment in 2.93% shares of OAO Gazprom. As a result of the swap the Group recognized the gain on disposal of interest in OAO Severneftegazprom and ZAO Gazprom YRGM Development in the consolidated statement of comprehensive income in the amount of RR 105,470, being the difference between carrying amount of transferred assets and respective fair value of ZAO Gerosgaz shares acquired. Treasury shares were recognized as deduction from equity at market value as at the date of the swap closure.

Finance income (expense)

Exchange gains decreased by RR 188,592 million to RR 150,384 million in the year ended 31 December 2010, compared to RR 338,976 million in the year ended 31 December 2009. Exchange losses decreased by RR 236,887 million to RR 130,433 million in the year ended 31 December 2010 from RR 367,320 million in the year ended 31 December 2009. The decrease in exchange gains and exchange losses resulted from a lower fluctuation of USD and EUR exchange rates against RR in the year ended 31 December 2010 in comparison with the year ended 31 December 2009.

Interest income decreased by 44% to RR 20,692 million in the year ended 31 December 2010 from RR 36,762 million in the year ended 31 December 2009, mainly due to change of presentation of the Group's banking subsidiaries in the first half of 2010.

Interest expense decreased by 48% to RR 38,714 million in the year ended 31 December 2010 from RR 74,167 million in the year ended 31 December 2009, mainly due to decrease in average borrowings balance during the year ended 31 December 2010 in comparison with the prior year.

Share of net income of associated undertakings and jointly controlled entities

Share of net income of associated undertakings and jointly controlled entities increased by RR 13,963 million, or 22%, to RR 76,520 million in the year ended 31 December 2010 compared to RR 62,557 million in the year ended 31 December 2009. The increase of the Group's share of net income of associated undertakings and jointly controlled entities in the year ended 31 December 2010 relates mainly to increase in net income of Sakhalin Energy Investment Company Ltd. due to increase in sales of hydrocarbons.

Profit tax

Total profit tax expense increased by RR 90,068 million, or 49%, to RR 275,710 million for the year ended 31 December 2010 compared to RR 185,642 million for the year ended 31 December 2009. The effective profit tax rate was 21.6% and 19.0% in the years ended 31 December 2010 and 2009, respectively. The change in the effective tax rate results mainly from the effect of one-time non-taxable income related to the purchase of an additional interest in OAO Gazprom neft and the gain from swap of assets with E.ON Ruhrgas in 2009 and in 2010 to effect of the disposal of interest in OAO Novatek.

Profit for the period attributable to owners of OAO Gazprom

As a result of the factors discussed above, our profit for the period attributable to owners of OAO Gazprom increased by RR 188,972 million, or 24%, from RR 779,585 million in the year ended 31 December 2009 to RR 968,557 million in the year ended 31 December 2010.

Profit for the period attributable to non-controlling interest

Profit for the period attributable to non-controlling interest increased by RR 15,228 million, or 107%, to RR 29,436 million in the year ended 31 December 2010 compared to RR 14,208 million in the year ended 31 December 2009. Increase is mainly related to the increase of profit of OAO Severneftegazprom and OAO Mosenergo in the year ended 31 December 2010 compared to the year ended 31 December 2009.

Liquidity and capital recourses

The following table summarizes our statement of cash flows:

Net cash provided by operating activities

Net cash provided by operating activities increased by RR 562,962 million, or 63%, and amounted to RR 1,460,116 million in the year ended 31 December 2010 compared to RR 897,154 million in the year ended 31 December 2009. The increase was primarily due to growth of our operating profit in the year ended 31 December 2010 in comparison with the year ended 31 December 2009, which was supplemented by positive dynamics of changes in working capital.

Net cash used for investing activities

Net cash used for investing activities increased by RR 57,196 million, or 6%, to RR 1,050,307 million in the year ended December 31, 2010 compared to RR 993,111 million in the year ended December 31, 2009. This increase relates mainly to the increase in cash used for capital expenditures in development of fields and transport infrastructure which was partly offset by decrease in cash used for acquisition of shares in subsidiaries due to purchase of non-controlling interest in OAO Gazprom neft for RR 138,527 million in the year ended 31 December 2009.

Net cash used for financing activities

Net cash used for financing activities amounted to RR 212,384 million in the year ended 31 December 2010 compared to net cash used for financing activities in the amount of RR 2,867 million in the year ended 31 December 2009. This increase was due to change from net proceeds from long term loans and borrowings in 2009 to net repayment in 2010.

Working capital

The working capital surplus (current assets less current liabilities) was RR 854,634 million as of 31 December 2010 and RR 639,082 million as of 31 December 2009. The RR 215,552 million increase in our working capital in the year ended 31 December 2010 was primarily due to a decrease in short-term borrowings and current portion of long-term borrowings and an increase in cash and cash equivalents. These effects were partially offset by an increase in accounts payable.

The decrease in short-term borrowings and current portion of long-term borrowings in the amount of RR 234,010 million was caused mainly by deconsolidation of Group's banking subsidiaries, and also by redemption of loans and loan participation notes issued.

The increase in cash and cash equivalents amounting to RR 191,027 million was caused by the increase of cash on Group accounts.

The increase in accounts payable and accrued charges amounting to RR 200,565 million was caused mainly by increase in advances received for gas sold, increase of trade payables for gas sold, and also by increase in trade payables related to investment construction.

Management believes that the Group has sufficient working capital to meet the Group's obligations for at least the next twelve months. However, the Group is dependent on the short-term credit markets to finance its working capital. The Group is also dependent on a regular access to the domestic debt capital markets to meet a significant portion of its financing requirements in Russian rubles.

Capital expenditures

Total capital expenditures (excluding the effect of acquisitions of subsidiaries) by segment for the years ended 31 December 2010 and 2009 in nominal RR terms, amounted to the following:

Note:

(1) The capital expenditures in the present analysis differs from the capital additions disclosed within the Group's business segments in IFRS consolidated financial statements of OAO Gazprom primarily due to VAT.

Total capital expenditures (excluding the effect of acquisitions of subsidiaries) increased by RR 299,964 million, or 37%, from RR 810,870 million in the year ended 31 December 2009 to RR 1,110,834 million in the year ended 31 December 2010.

The increase of our capital expenditures in the Transport segment was primarily due to increased capital expenditure on the construction of major transportation projects, including Sakhalin-Khabarovsk-Vladivostok, Pipeline Bovanenkovo-Uhta, and Gryazovets-Viborg. The increase of our capital expenditures in the Refining segment was primarily due to increased capital expenditure of OAO Gazprom neft. The increase of our capital expenditures in the Electric and heat energy generation and sales segment was primarily due to consolidation of TGC-1 starting from 31 December 2009 after control over that entity was obtained.

Debt obligations

Net debt balance (defined as the sum of short-term borrowings, current portion of long-term borrowings, short-term promissory notes payable, long-term borrowings, long-term promissory notes payable and restructured tax liabilities, net of cash and cash equivalents and balances of cash and cash equivalents restricted as to withdrawal under the terms of certain borrowings and other contractual obligations) decreased by RR 501,314 million, or 37%, from RR 1,372,307 million as of 31 December 2009 to RR 870,993 million as of 31 December 2010. This decrease resulted from decrease of short-term and long-term borrowings, which was primarily caused by the effect of early redemption of long-term borrowings, deconsolidation of banking subsidiaries of the Group as of 31 December 2010 and the increase in cash and cash equivalents.